So you want to get into a career in financial modeling? and want to learn Financial Analysis for Dummies?
Well, just like the other disciplines, you need to start with the basics.
This guide will help you build a good foundation before you study complex financial valuations or models.
To better help you out, we have an Excel file named “Excel Counterpart –Basic Finance”. This excel file, along with this guide, will help you navigate your way through the basics of Finance.
Let’s dive right in!
One of the most important basic things you need to learn in Finance is how to accurately interpret the financial statements.
Most of the time, they are the sources of financial information you’ll use for different types of models or analysis.
Usually, there are only three financial statements that are being frequently used by financial analysts. They are the balance sheet, income statement and cash flows statement.
The Balance Sheet (or Statement of Financial Position for purposes of International Financial Reporting Standards) is the financial statement that presents a company’s assets, liabilities, and equity during the end of the financial reporting period.
Let’s examine the following sample balance sheet.
First of all, take note of the title. The third line says “As of December 31, 20xx”. This denotes that the report is accurate only at a certain period in time, which is the end of the reporting period.
The balances at that point in time is a good representation of what transpired during the year.
For example, if Fixed Assets of 2019 balance sheet is $100,000 greater than its 2018 counterpart, then, it only means that the company made acquisitions during 2019.
As you can see from our example balance sheet, the amounts divide into three main groups namely:
Notice that there are even subgroups:
The balance sheet is usually presented by order of liquidity (meaning the ease of converting to cash).
For example, in the Assets section, Cash is on the topmost part because it is the most liquid.
Next are the receivables since they can easily be monetized through the collection.
The Non-current Assets are second to the Current Assets because they are hard to realize within a short period of time.
The Liabilities, on the other hand, are arranged according to maturity.
Thus, all current liabilities are due within one year. All non-current liabilities are due after more than a year.
Long-term investments that have a maturity date, when already due within one year, are transferred from Non-current Assets to Current Assets.
Income Statement (or Statement of Recognized Income and Expenses under International Financial Reporting Standards) is the statement that presents the income and expenses throughout the reporting year.
The title must show the company name and the label “Income Statement“ or “Statement of Recognized Income and Expenses”.
The third line is the date covered which says “For the Period Ending date”.
Note that there is the keyword “Period”. It tells us that the figures were accumulated during that period only.
This is unlike the balance sheet wherein the figures may be accumulated from different accounting periods.
The contents of income statements may vary depending on the nature of the business. What’s important here is that the amounts should be properly labeled. The Net Income endow at the bottom of the statement.
The main components are Sales, Costs, Gross profit, and Net profit (Net income).
Cash is king, as they say.
Perhaps it’s a statement of how important Cash is to every business. That importance gave rise to a statement focusing on the cash only – Cash Flow statement.
The statement focus on presenting the various uses of Cash for the reporting period.
Just like the income statement, the contents of Cash Flow Statements cover the transactions throughout the reporting period.
For our example above, the business uses a calendar period, thus, the coverage of its Cash Flow Statement is from January 1 to December 31.
The Cash Flow Statement divides into three parts:
Notice in our sample Cash Flow Statement that the Cash Flow from Operating and Investing Activities is positive. It means that there are more Cash Inflows than Cash Outflows, thus, the Operating and Investing Activities of the business increased the Cash balance of the company.
Meanwhile, the financing activities reduced Cash by $25,000. Most of the cash outflows went to paying dividends and long-term notes payable.
I hope you liked the comprehensive guide to Financial Analysis for Beginners. Let me know in the comments section how will you plan your strategy.